GLOBAL ABSOLUTE BOND ALERT

RESTRUCTURING OF FOREIGN CURRENCY CONVERTIBLE BONDS

The current economic scenario has created a huge pressure on companies who have issued Foreign
Currency Convertible Bonds in the recent past and are facing redemption of the outstanding bonds. In
the vast majority of circumstances, restructuring out of court is the preferred approach, for a number of
reasons:

• Transaction costs are less than on court proceedings.

• It is easier for existing management to control the process.

• Publicity will be avoided or at least reduced.

Non-judicial options are particularly desirable in cross-border transactions because, to date, no
comprehensive worldwide judicial restructuring scheme has emerged. Bondholders should understand
that developing and implementing a restructuring philosophy is increasingly viewed, by both
management and sophisticated creditors such as institutional bondholders, as a positive step towards
managing financial problems because a restructuring does not always lead to a insolvency filing, and
there are many tools that can and should be considered long before the in-court option in order to
diminish the negative effects on the business. In addition, any petition for restructuring should be
considered as one of many useful tools in the restructuring toolkit, and as such is not an admission of
defeat but rather, often, a creative and aggressive restructuring alternative. The company and the
bondholders have a choice of several mechanisms for implementing their restructuring plan, including:

• Waivers.

• Repurchasing the bonds

• Exchange offers
The choice of mechanism will depend heavily on the specific challenges facing the company. In some
circumstances, a combination of options should be considered.

WAIVERS AND SUPPLEMENTAL INDENTURES

If the company is facing a short-term financial difficulty but appears capable of an imminent
turnaround on an operational level, such that it ultimately will be able to repay the principal and all
interest on the bonds, the best solution may be a short-term waiver or amendment of the issuing
documents (such as the indenture or fiscal agency agreement) that can be quickly accomplished out-of-
court. Most bond issuances require unanimous consent of every bondholder in order to amend or
modify monetary terms of the bonds (such as principal amount, interest rate and term). However, the
non-monetary covenants that restrict various activities of the issuer can be amended by a vote of a
controlling majority. Similarly, it is often possible for a controlling block of bondholders to agree to
refrain from declaring a default or taking collection action over certain covenant defaults. If such a
modification is sufficient to solve the company’s financial difficulties (for example by allowing new
borrowing, eliminating troublesome financial covenants or allowing sales of assets), the company can

1 | P a g e  

 
GLOBAL ABSOLUTE BOND ALERT

negotiate to pay a consent fee to a controlling block of the bondholders in exchange for their agreement
to the proposed amendment.

REPURCHASE OF BONDS

When a non-monetary covenant modification or waiver is not sufficient, a company may achieve relief
from temporary liquidity problems by offering to repurchase sufficient debt securities, which will
undoubtedly be trading at a discount from the face amount, in order to clean up its balance sheet. A
buyback can be accomplished in an open market purchase, through private negotiations with large
holders, or using a public tender offer. Common strategies include:

• Selling non-essential assets and using the proceeds to repurchase debt.

• Raising funds for a discounted debt repurchase by issuing new debt securities or obtaining new
bank financing.
If turnaround does not occur through the bond buyback alone, the company may still be in a better
position (as a result of its improved balance sheet) to obtain additional financing, through, for example:

• Traditional debt offerings.

• Loans or hybrid debt instruments such as convertible preferred stock.

The additional financing can be used to support continuing operations and to pay the remaining
bondholders in the class on maturity.

EXCHANGE OFFERS

When more far-reaching relief is needed and the company does not want to spend the cash necessary
for a bond repurchase, an exchange offer should be considered. An exchange offer is an offer by the
company to exchange new debt or equity securities for the existing bonds.

In the exchange, the company can offer:

• A new debt package with some combination of reduced principal, reduced interest rates, an
extension of maturity or debt amortizations, and improved covenants that allow more flexibility to
accommodate an operational restructuring.

• Collateral in exchange for concessions on other terms or, depending on the exact exchange
mechanism, a small current cash payout.

• Particularly where the company’s equity market capitalization is high, a debt-for-equity swap that
takes advantage of high equity trading values to retire bond debt without a cash outlay.

OVERCOMING THE FREE RIDER PROBLEM

In deciding on an implementation strategy, the management team and its advisers should be prepared
to consider and proactively address several potential obstacles that may complicate efforts to finish the

2 | P a g e  

 
GLOBAL ABSOLUTE BOND ALERT

restructuring out of court. One of the most significant challenges in restructuring most bond debt can
be described as the “free rider” problem. The consent of each individual bondholder is generally
required if critical terms of the bonds are to be modified. In a widely-held issuance, it is virtually
impossible to achieve unanimous consent − one holdout (a party that refuses to agree) or unidentifiable
bondholder can block an otherwise consensual deal. Similarly, in an exchange offer or buyback
situation, any single bondholder may choose not to exchange, tender or sell its bonds and will be left
with the old securities that it held before the exchange. This situation could benefit the holdouts. Many
investors assume that once the restructuring transaction is completed, their old unmodified bonds will
be more valuable because:

• The issuer’s balance sheet will have improved and there will be cash available to satisfy the bonds
in full instead of at the discount that consenting bondholders agreed to.

• The more stringent covenants or other requirements of the holdout’s unmodified bonds may even
force the company to retire the bond debt early through payment in full.
The holdout problem can cause significant execution risk for a restructuring because:

• A company often will not want to complete the deal if there is a large block of holdout debt still
outstanding.

• Bondholders who otherwise would have agreed to a restructuring deal may not want to shoulder
the burden of that deal while others have a free ride.
The use of an “exit consent” element in an exchange or tender offer can shift incentives to ease the free
rider problem. Most bond indentures include a provision permitting a majority or supermajority in
principal amount of the bonds to amend certain indenture provisions. The company can therefore
make the tender or exchange of bonds conditional on an agreement (the exit consent) to the elimination
of certain covenants in the existing bonds. Exit consents create a “prisoners’ dilemma” for bondholders:

• Each bondholder must consider that if a sufficient majority of the other bondholders accept the
deal, the covenant changes will become effective.

• If the bonds are stripped of their protective covenants, the bondholders who do not tender could be
left without a remedy if there is a subsequent sale, refinancing or recapitalization of the company.
Therefore, where there is a risk of covenant-stripping, there is a powerful incentive to participate in the
tender or exchange. This in turn minimizes the likelihood of free riders.

3 | P a g e  

 
GLOBAL ABSOLUTE BOND ALERT

CONCERNS RELATING BOND RESTRUCTURING STRATEGIES

Apart from the “Free Rider” problem, many such FCCB issuer companies and the bondholders have
several queries regarding the implementation of strategies relating to bond restructuring. Several of
those are being discussed and are as follows:

USE OF FRESH EXTERNAL COMMERCIAL BORROWINGS

External Commercial Borrowings can be either in the form of loans or foreign currency convertible
bonds. The actual law suggests that “the funds used for the buyback shall be out of existing foreign currency
funds held either in India (including funds held in EEFC account) or abroad and / or out of fresh ECB raised in
conformity with the current ECB norms and where the fresh ECB is co-terminus with the outstanding maturity
of the original FCCB and is for less than three years, the all-in-cost ceiling should not exceed 6 months Libor plus
200 bps, as applicable to short term borrowings. In other cases, the all-in-cost for the relevant maturity of the
ECB, as laid down in A. P. (DIR Series) No.26 dated October 22, 2008 shall apply”.

Henceforth it would be strongly concluded that the fresh ECB may be either be a foreign loan or an
issue of fresh FCCBs. That implies that fresh ECB which has been raised via issuance of new FCCBs or
foreign debt, can be used to repay the existing FCCBs.

From a commercial point of view, if the debt equity ratio of an issuer company is already high, raising
fresh loans only adds to the liabilities of the company. So any sort of restructuring mechanism should
be from the perspective that the company’s balance sheet do not get leveraged to a very high extent.

FLOOR PRICE GUIDELINES

In order to bring the ADR/GDR/FCCB guidelines in alignment with SEBI’s guidelines on domestic
capital issues, Government, vide Press Note No. 15/4/2004-NRI dated August 31, 2005, amended the
pricing norms for Indian listed companies issuing ADR/GDR/FCCB. Henceforth the guidelines issued
by the Ministry of Finance only brings the pricing norms of such foreign instruments in alignment with
the domestic issues. Several queries have come across regarding the ruling authority of such pricing
norms. Our answer to that is the Pricing norms are a mandatory regulatory issue which under any
circumstances has to be complied with. The pricing norms are issued by Ministry of Finance strictly
applicable to FCCB / ADR / GDR.

It should be also noted here that the pricing norms has been changed recently. The amendments has
been made on 21 November 2008, which provides that the pricing should not be less than the average
of the weekly high and low of the closing prices of the related shares quoted on the stock exchange
during the two weeks preceding the relevant date and the “relevant date” means date of the meeting in
which the Board of the company or the Committee of Directors duly authorized by the Board of the
company decides to open the proposed issue.

TENURE OF NEW FCCBS

4 | P a g e  

 
GLOBAL ABSOLUTE BOND ALERT

Fresh external commercial borrowings may be raised by issuing fresh foreign currency convertible
bonds to finance the prepayment of the existing bonds. The new FCCBs , under the applicable policies
on External Commercial Borrowings, amended till date. The New FCCBs may be issued for such tenure
which may co-terminate with the existing FCCB or may extend further. It should be noted here that
only if the where the fresh ECB is co-terminus with the outstanding maturity of the original FCCB and
is for less than three years, the all-in-cost ceiling should not exceed 6 months Libor plus 200 bps, as
applicable to short term borrowings.

Scenario Analysis

If a company has issued bonds in FY 2007 pending maturity in FY 2012, and the company further raises
debt by issuing new FCCBs in FY 2009 or on such date which is post the issue of buyback regulations
by RBI), the following rates are applicable.

Issue Date Maturity Date YTM

2007 2012 (5 Years 1 Day) 6 Month LIBOR+350 Basis Points

2009 2012 (concurrent with the date of maturity of 6 Month LIBOR+200 Basis Points 
the initial issue)

2009 2014 (If the new FCCBs mature between three 6 Month LIBOR+300 Basis Points 
years to five years from the date of issue)

2009 2014 (More than five years) 6 Month LIBOR+500 Basis Points 

ARE DIVERSTITURES OR PRIVATE EQUITY BAILOUTS FEASIBLE?

Recently, an Indian Company Wockhardt Ltd., whose outstanding bonds are pending recent
redemption, has decided to sell assets to raise money to partly repay liabilities arising out of the
redemption of $110 million worth of foreign currency convertible bonds (FCCBs). Wockhardt has
sought to raise around $150-200 million (Rs750-1,000 Crore) for repaying these liabilities. The company
has taken a decision at the board level to sell off some of the non-operational assets in India or abroad
to pay up the liabilities. With reference to the circumstance we are of the opinion that the current
market conditions would not fetch a proper value to the assets of a company, which may include its
foreign subsidiaries. The circumstances must be compelling and grueling enough to force such
demergers or divestitures, but from a practical point of view such procedures are time consuming as it
would undoubtedly involve negotiations, documentation and implementation phases. Strategic buyers
may look for cheaper rates whereas the Seller company may look forward for such value which may
not be consensus ad idem with the proposition of the strategic buyer. And the other roadblock would
be low valuation of the assets.

5 | P a g e  

 
GLOBAL ABSOLUTE BOND ALERT

It should be also noted that Wockhardt discussed the sale with at least two Private Equity firms in
November 2008. An overseas drug maker had also shown interest in buying a strategic stake in the
company. The talks, however, hit the same roadblock as Wockhardt expected a high valuation. Private
Equity bailouts would also mean a significant dilution at the company level. Under the present
scenario companies having low market capitalizations, they may find it extremely difficult to dilute
26% or more. The scenario is worst in cases, where the promoters holding is less than 25%. We have
queries which seek solutions regarding non dilution under such circumstances. We prescribe the issue
of preference capital to such investors. The advantages and disadvantages are as follows:

Advantages
1. In case of payment of dividends, it carries a preferential rights over equity shares for payment of a
fixed rate/amount of dividends.
2. In case of winding up or repayment of share capital of the company, a preferential right over the
Equity shares for repayment of paid-up amount of shares.
Disadvantages
The main drawback of preference shares is that they carry limited voting rights. As distinguished from
an equity share, a preference share carries voting rights only with respect to matters which directly
affect the rights of the preference shareholders. In this regard, the Act clarifies a resolution relating to
winding-up and repayment or reduction of capital is deemed to directly affect the rights of the
preference shareholders. Due to these limitations on voting rights, a preference shareholder does not
have much control over the company. However, a preference shareholder may acquire voting rights on
par with an equity shareholder if the dividend on preference shares is in arrears. In case of cumulative
preference shares, for an aggregate period of not less than two years on the date of the meeting
(cumulative preference shares are preference shares on which the unpaid dividend accumulates as
arrears) and in case of non-cumulative preference shares: for not less than two financial years
immediately preceding the meeting; or for any three years, during a period of six years ending with the
financial year preceding the meeting. (Section 85(2)(b) of the Companies Act 1956). The other drawback
of preference shares is that they have to be redeemed within twenty years from their issue. (Section
80(5A) of the Companies Act 1956).

TAKEOVER CODE

A pertinent question has been raised under the circumstances relating to trigger of takeover code on
conversion of outstanding foreign currency convertible bonds into equity shares of a company. We
conclude that conversion of the bonds into shares such that the erstwhile bondholder becomes the
owner of more than 15% shareholding in the Company have to comply with the takeover provisions.
Likewise Global Depository Receipts when being converted into its underlying equity shares also
triggers the takeover code.

6 | P a g e  

 
GLOBAL ABSOLUTE BOND ALERT

Salient Features of the Takeover Code

Any acquirer (defined as a person who, directly or indirectly, acquires or agrees to acquire shares or
voting rights in a company or acquires or agrees to acquire control over a company, either by himself
or with any person acting in concert) who acquires shares or voting rights that would entitle the
acquirer to more than 5%, 10%, 14%, 54% and 74% of the shares or voting rights, (as the case may be),
in a company is required to disclose the aggregate of his shareholding or voting rights in that company
to the company and to each of the stock exchanges on which the company's shares are listed within two
days of (i) the receipt of allotment information or (ii) the acquisition of shares or voting rights, as the
case may be. The term "shares" is defined under the Takeover Code to mean " shares or any other
security which entitles a person to acquire shares with voting rights, but excludes preference shares."
FCCBs as Instruments for Hostile Takeovers
The recent take-over saga, of Orchid Chemicals & Pharmaceuticals by Solrex Pharma, a firm reported
to be of Ranbaxy Group has opened up a new venue of discussion. Orchid Chemicals had issued FCCB
of US $ 175 million in late 2007, having conversion option at Rs.348.335 per share. Till 31st March 08,
nobody would have imagined to convert them into equity as the share price was hovering around
Rs.150 per share. Since these FCCB holders would be entitled to receive about 20 million equity share of
the company, which amounts to about 23% of the post-issue equity of Rs.86 Crore, any acquirer having
an eye on Orchid would go ahead with this conversion. The attraction gets added if the promoter’s
stake is low, which is, in this case is at about 16%. In view of share price of Orchid ruling at around
Rs.150 per share, in March 08, acquisition of close to 12% stake, of pre-issue equity of Rs.66 Crore, made
the share price to rise to Rs.230 levels. Hence, this 12% stake, which is about 9% of post FCCB
conversion equity, would give control of about 32% stake to a prospective acquirer at an average rate of
Rs.307 per share. Not a bad deal at all for the take-over of Orchid.
The acquisition process becomes much economical if FCCB terms have Reset Clause. Reset Clause
generally exists in case of mid-size companies, where a clause is inserted to re-work the conversion
price, in the event share price of the company falls on the stock exchange. In such an event, FCCB
holders get a revised offer at a lower rate, to convert FCCB into equity shares. The pain is not much for
the promoters where FCCB conversion would eventually lead to below 10% increase in equity and
where promoters have a stake of 20% and above. But the pain increases for converse cases and
especially where FCCB have Reset Clause. With this situation persisting, it is likely to see many such
cases of corporate raids being initiated by the potential acquirer on the lines of Orchid Chemicals.

CONVERSION PRICE RESET AND FLOOR PRICE

During issue of FCCBs, the Issuer provides the Trustee with an opinion of reputed legal counsel in
India, stating that the Conversion Price as proposed to be reset in accordance with the terms and
conditions of the bonds is higher than or equal to the minimum floor price stipulated by the Ministry of
Finance of the Government of India (the ""Minimum Floor Price'') to the extent that, under applicable
law, the Conversion Price is prohibited from being below the Minimum Floor Price and that the
proposed resetting of the Conversion Price would not require the approval of the Reserve Bank of

7 | P a g e  

 
GLOBAL ABSOLUTE BOND ALERT

India, the Ministry of Finance, India and/or any other governmental/regulatory authority in India. The
conversion price is also determined by various other factors. The Conversion Price of the Bonds will be
adjusted in certain events occurring after the Issue Date, including upon (i) bonus issues of shares, (ii)
free distribution of shares, (iii) sub-division, consolidations and reclassification of shares, (iv) issuance
of rights to acquire shares, (v) issuance of warrants at a discount to the prevailing market price (vi)
issuance of convertible bonds and exchangeable bonds at below market price and (vii) issuance of
shares at below market price.

Many offering circulars of FCCB states the following in relation to conversion price reset.

“The applicable Conversion Price will be reset downwards only on any Reset Date (as defined in Condition [•])
to be the higher of (a) the volume weighted average closing price of the Shares on the BSE for thirty (30) Trading
Days immediately prior to the relevant Reset Date; or (b) the SEBI floor price at the relevant Reset Date if such
price is lower than the applicable Conversion Price, except that the reset Conversion Price shall in no event be less
than Rs. [●] per Share.”

Some of the offering circulars also state that:

“Notwithstanding the provisions of this Condition [●], the Issuer covenants that (i) the Conversion Price shall
not be reduced below the par value of the Shares (Rs.[●] at the date hereof) as a result of any adjustment or reset
made hereunder or for any other reason whatsoever unless under applicable law then in effect Bonds may be
converted at such reduced Conversion Price into legally issued, fully-paid and non-assessable Shares; and (ii) it
will not take any corporate or other action which may result in the Conversion Price being reduced below the
Minimum Floor Price (as defined in Condition [●] below)”

So we accordingly conclude:

Par Value Floor Price Conversion Price

The conversion price would be adjusted between the
Initial Conversion Price and the Par Value and the
adjusted conversion price should not be less than the
par value of a share, if expressly stipulated in the
Trust Deed and the Offering Circular. However many
such companies express that under any
circumstances, the Conversion Price would not be
reduced below the Minimum Floor Price.
The conversion price would be adjusted between the
Initial Conversion Price and the Floor price, and the
adjusted conversion price should not be less than the
Floor price, if expressly stipulated in the Trust Deed
and the Offering Circular.

COMPANIES OPTING FOR CDR MECHANISM

Corporate Debt Restructuring or CDR is the reorganization of a company's outstanding obligations

mostly done by reducing the burden of the debts on the company by decreasing the rates paid and
increasing the time the company has to pay the obligation back. A Classic illustration is that of
Wockhardt which has moved to the CDR cell for restructuring its liabilities that typically include lower
interest rates and a longer, easier payment schedule to reduce the debt burden. ICICI Bank is
8 | P a g e  

 
GLOBAL ABSOLUTE BOND ALERT

Wockhardt’s lead banker while IDBI is the nodal agency for the CDR cell, a forum set up by Indian
banks to deal with companies that are unable to service their debt. The FCCBs will be part of the CDR
scheme, since they are on the company’s balance sheet. Wockhardt had issued FCCBs worth nearly
$110 million two years ago to fund its aggressive overseas expansion. The FCCBs are currently trading
at 60% discount, and are due to mature in October 2009. This is the first time that FCCBs will be part of
a debt restructuring process involving an Indian company. Wockhardt, which approached the CDR cell
on March 31, 2009 to restructure its liabilities in the wake of a liquidity crisis, is expected to finalize the
CDR programme within four months. Wockhardt’s debt aggregated to Rs 3,400 Crore on December 31
2008. Of this, the company borrowed around $450 million in foreign currency while the remaining
comprises domestic loans. Restructuring of Wockhardt’s debt would not be a meaningful exercise,
unless foreign borrowings are also part of the process. A strong possibility is that the foreign branches
of Indian lenders would buy the FCCBs from foreign investors.

CONCLUSION

There is no over-the-counter, one-type-cures-all pill that troubled companies can swallow when they
are in financial difficulty. Every company is unique and the factors that lead to financial problems, as
well as the formulae for renewed financial health, are as varied as the companies themselves. One
common challenge for nearly every company with outstanding public debt, however, is the need to
develop a strategy for negotiating with bondholders. Negotiations between a company and its
bondholders will proceed in a way that is distinct to the specific pressures facing the company. But
there are certain steps a company can take to achieve an outcome that will allow it to maximize its
chances of achieving a successful restructuring while keeping control of the process and keeping the
company’s business intact.

9 | P a g e